Balance Sheet Effects in Currency Crises: Evidence from Brazil

In third generation currency crises models, balance sheet losses from currency depreciations propagate the crises into the real sector of the economy. To test these models, we built a firmlevel database that allowed us to measure currency mismatches around the 2002 Brazilian currency crisis. We found that between 2001 and 2003, firms with large currency mismatches just before the crisis reduced their investment rates 8.1 percentage points more than other publicly held firms. We also showed that the currency depreciation increased exporters revenue, but those with currency mismatches reduced investments 12.5 percentage points more than other exporters. These estimated reductions in investment are economically very significant, underscoring the importance of negative balance sheet effects in currency crises. Jel Codes:F32; F34; G31; G32Investment; Balance sheets; Currency crises; Hedge; Financial constraints.

Balance Sheet Effects in Currency Crises: Evidence from Brazil

"Third-generation currency crises models" argue that capital losses from exchange-rate depreciation propagate the crises to the productive sector. To test these models, we use a firm-level dataset that allows us to measure currency mismatches around the 2002 Brazilian currency crisis. We find that, between 2001 and 2003, firms that shortly before the crisis had large currency mismatches decreased their investment rates by 8.1 percentual points, relatively to other public firms. Moreover, we show that the currency depreciation implied large competitive gains for the exporters, and yet the investment of exporters with large currency mismatches fell by 12.5 percentual points, relatively to other exporters. The estimated falls in investment are economically very relevant, thereby corroborating the relevance of third generation models negative balance sheet effects.

Do government guarantees really matter in fixed exchange rate regimes?

Since the mid 1990s, theories of speculative attacks have argued that fixed exchange rate regimes induce excessive borrowing in foreign currency as an optimal response to implicit guarantees that the government will not devalue the domestic currency. Using data on Brazilian firms before and after the end of the fixed exchange rate regime in 1999, we estimate the relevance of the government guarantees by comparing the changes in foreign debt of two groups of firms: those that hedged their foreign currency debt prior to the exchange rate float and those that did not. Using the difference-in-differences approach, in which firm-specific characteristics are introduced as control variables, we exclude the macroeconomic effects of the change in the exchange rate regime and the possible differences in foreign debt trends of the two groups of firms, thus obtaining an estimate of the impact of the government guarantees on borrowing in foreign currency. The results suggest that the guarantees do not induce excessive borrowing in foreign currency. JEL classifications: F31, F34, G15, G18, Keywords: Foreign exchange risk, Government guarantees, Exchange rate regime, Hedgin

Balance sheet effects in currency crises: Evidence from Brazil

In third generation currency crises models, balance sheet losses from currency depreciations propagate the crises into the real sector of the economy. To test these models, we built a firm-level database that allowed us to measure currency mismatches around the 2002 Brazilian currency crisis. We found that between 2001 and 2003, firms with large currency mismatches just before the crisis reduced their investment rates 8.1 percentage points more than other publicly held firms. We also showed that the currency depreciation increased exporters revenue, but those with currency mismatches reduced investments 12.5 percentage points more than other exporters. These estimated reductions in investment are economically very significant, underscoring the importance of negative balance sheet effects in currency crises